Ben Bernanke made news yesterday by committing to provide more accommodative monetary policy in an effort to spur a faster recovery—and specifically linking his moves to the Federal Reserve’s disappointment in the labor market recovery so far.
This is a welcome, if still insufficient, development.
Bernanke’s move comes after a widely-circulated paper by Michael Woodford was presented at the Fed’s Jackson Hole conference. The paper argued that the main beneficial impact of Fed easing was through its impact on expectations—that is, if the Fed could convince the public that it will not pull the plug on its support to the economy even if inflation begins to pick up, then they can convince businesses and households to start spending (the mechanisms is that the higher expected inflation rates can drive real interest rates lower even as the Fed’s nominal policy interest rates are stuck at zero). Woodford argues that the most powerful way these expectations are changed are simply through the Fed’s “forward guidance,” or, well, talking.
This raises two quick issues.
First, another key value in the Fed “talking” like it did yesterday isn’t just in trying to convince market participants about what future inflation will look like, it should also help to convince Congress that there remains a jobs crisis that they themselves can help solve. He specifically noted that too-tight fiscal policy was a clear “headwind” to growth in the coming year. In fact, the most valuable outcome of yesterday’s monetary policy moves may well be the nudge they give to changing the direction of fiscal policy.
Second, it’s hard to ignore that the finding on how powerful Fed-talk can be in spurring a depressed economy doesn’t hang very well with claims made during both the stock and housing market bubbles that there was nothing really the Fed could have done to keep them from inflating. After all, if Fed-talk can convince people, purely on the Fed’s say-so, that inflation will be higher three years from now than what they currently expect, then surely the Fed can also point out that when asset prices (stock prices and housing prices) are far out of line from economic fundamentals, that markets better do something about this imbalance or the Fed itself will.
Hopefully this new assessment of the value of Fed-talk will carry over to help prevent tomorrow’s bubbles.